Addressing fuel cost dispute calculations

July 3, 2019

This column published as "Know Your Procurement" in July 2019 issue

Because most state highway departments assume the risk of fuel cost escalation and include price adjustment clauses in their contracts, contractors generally experience no financial effects from varying fuel prices.

These clauses, however, are not always clear, and disputes sometimes arise concerning how adjustments are calculated under certain circumstances.

A case involving a contract to construct 6.25 miles of highway for the Mississippi DOT (MDOT) included a fuel adjustment clause that established a base fuel price upon which all bidders were to base their bids. Adjustments would be made on each pay estimate based upon variances between the base price and a specified index that MDOT publishes each month. The last sentence of the clause addressed adjustments for work performed after the contract completion date as follows: “After expiration of the contract time, including all extensions, adjustments will be computed using fuel and material prices that are in effect at the expiration of the contract time.”

Once the contractor exceeded the adjusted contract completion date, MDOT began making fuel adjustments in accordance with its interpretation of the provision, which was to essentially freeze the monthly index price as of contract completion date, and all payments thereafter were made based upon the difference between the original baseline price and the “frozen” index price. The rationale for the freeze was clearly to place the risk of fuel increases back on the contractor.

The contractor did not object because for many months thereafter, fuel prices were fairly stable. However, when Katrina struck in August 2005, prices skyrocketed and MDOT continued making adjustments based upon the relatively small variance between the original baseline price and the “frozen” index price. From this point, the contractor lost nearly $500,000 and consequently filed a claim, which MDOT denied. The contractor sued. 

The contractor argued that the adjustment clause merely requires MDOT to reset the original baseline price to the index price current as of the contract completion date and each subsequent monthly adjustment should be based upon the difference between the revised baseline and the current index price. It also argued that if MDOT’s interpretation is a correct one, the clause violates the state statute that grants it the authority to include fuel price adjustment clauses in its contracts.

The trial court rejected both arguments and the contractor appealed to the state Supreme Court. Like the trial court, the Supreme Court agreed with MDOT’s interpretation. However, it agreed with the contractor’s contention that the clause exceeds the statutory authority granted MDOT to include such clauses in its contracts, and it remanded the case back to the trial court for a full trial.

The statute provides as follows: Any agency or governing authority authorized to enter into contracts for the construction, maintenance, surfacing or repair of highways, roads or streets, may include in its bid proposal and contract documents a price adjustment clause with relation to the cost to the contractor, including taxes, based upon an industry-wide cost index, of petroleum products including asphalt used in the performance or execution of the contract. ... The price adjustment clause shall be based on the cost of such petroleum products only and shall not include any additional profit or overhead as part of the adjustment.

The court focused on the requirement in the statute that adjustments must be made “with relation to the cost to the contractor” and ruled that by freezing the index after the contract completion date, subsequent adjustments were arbitrary and thus no longer took the contractor’s cost into account.

Although this outcome is a rare one, it highlights the importance of procurement-related statutes in public contracts. Certain procurement statutes provide additional contract terms that although not expressly written in the contract are nevertheless regarded as part of it. Other statutes expand on the meaning of written terms. As demonstrated in this case, statutes can actually take precedence over written contract terms and even invalidate them, especially if they are written contrary to a particular statute. To fully understand contracts, public contractors must familiarize themselves with the procurement statutes in the states in which they work.

About The Author: Caudle is a principal in Kraftson Caudle LLC, a law firm in McLean, Va., specializing in heavy-highway and transportation construction. Caudle can be contacted via e-mail at [email protected].

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